SVB, 2007 REDUX OR AN ABERRATION?

In a very shocking development in the USA one of the biggest banks, namely the Silicon Valley Bank has collapsed. The US regulators have shut the bank down Friday. The bank was involved in funding a lot of start ups in the California region and had funded many other start ups through funding to VCs. This collapse is reminiscent to what happened in 2007-2008 in the sub prime lending era. What led to this collapse? 

As we all know US is a business-friendly country. Funding is available at very low interest rates which helps businesses grow rapidly and exponentially. Many a times risk is overlooked in pursuit of rapid growth and becomes the undoing for the entire economy.

During the Covid period when entire business activity across the world came to a standstill, many countries took to fiscal stimulus to improve industrial activity as well as provide impetus to growth. The US also provided a fiscal stimulus albeit by providing cash assistance to its citizens. In pursuing growth, the US resorted to printing money and distributing it to all and sundry. The easy availability of money meant people had more expendable surplus, which, went to markets as well as banks, setting investment products like equities, precious metals et all on fire.

Silicon Valley Bank also had big influx of money in the form of deposits. The bank chose to invest in relatively safer bet, that is bonds. The bank estimated that bond yields in the longer run would remain stagnant and this is where the problem started. They say "never put all eggs in one basket", the SVB however. invested around 80% of its deposits in long term bonds expecting yields to remain steady. The yields could have been steady but the Russia-Ukrain war threw the world in a spiral of rising inflation. The US along with the entire west sanctioned Russia endangering their own economies more than Russia. Inflation rose to unprecedented levels in the US prompting the Fed to act tough on the interest rate side. The fastest and easiest way to tackle inflation was undertaken and we saw a series of interest rate hikes. This hike had an impact on the equity markets as well as the bond markets. The equity markets in the US remained range bound in the series of interest rate hikes and bond markets remained volatile while yields for long term bonds went up. As interest rates rose liquidity was sucked out of the system. Banking system also bore the brunt of this liquidity shortage along with start up ecosystem. The Silicon Valley Bank had to cater to rising demand by the depositors, which it tried to cater to by selling its long term investment in bonds. The bond yield, however had shot up due to higher interest rates resulting in losses when the bank sold its portfolio. The bank lost over $1 bn in this transaction and depositors were requested not to withdraw their deposits. The bank is now well and truly under control of the regulator and there may be some more bad news in this context. The financial world needs to brace itself for aftershocks. We may indeed be on the brink of a recession and the Silicon Valley Bank might be the first casualty of the impending doom.